Question

Assume there are three companies that in the past year paid exactly the same annual dividend of​ $2.14 a share. In​ addition, the future annual rate of growth in dividends for each of the three companies has been estimated as​ follows (attached). Assume that as the result of a strange set of​ circumstances, these 3 companies all have the same required rate of return 11%

(Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Buggies-Are-Us g = 0 (i.e., dividends are expected to remain at $2.14/share) Steady Freddie, Inc g = 7% (for the foreseeable future) Gang Buster Group Year 1 $2.41 Year 2 $2.71 Year 3 $3.05 Year 4 $3.43 Year 5 and beyond: g = 7%

A. Use the appropriate DVM to value each of these companies. (round each to the nearest cent)

For​ Buggies-Are-Us, the value of the​ company's common shares is (blank$) ?

For Steady​ Freddie, Inc., the value of the​ company's common shares is (blank$) ?

For Gang Buster​ Group, the value of the​ company's common shares is (blank$) ?

What is the major cause of the differences among these three​valuations? (multiple choice)

A. The value of​ Buggies-Are-Us is ​$19.45 compared to ​$57.25 for Steady​ Freddie, Inc., and ​$69.30 for Gang Busters Group. The difference in values is caused by the difference in dividend growth rates. The​ Buggies-Are-Us dividends do not​ grow, resulting in the lowest value. The dividends of Steady​ Freddie, Inc., grow at a constant rate of 7​% ​forever, whereas Gang Busters​ Group's dividends grow at approximately​ 12% for the first four years and 7% from year five to the foreseeable future. The higher growth in dividends in the earlier years causes the stock of Gang Busters Group to be worth more than Steady​ Freddie, Inc., stock.

B.The value of​ Buggies-Are-Us is ​$19.45 compared to ​$57.25 for Steady​ Freddie, Inc., and ​$69.30 for Gang Busters Group. The difference in values is caused by the difference in dividend growth rates. The​ Buggies-Are-Us dividends do not​ grow, resulting in the lowest value. The dividends of Steady​ Freddie, Inc., grow at a constant rate of 7​% ​forever; whereas Gang Busters​ Group's dividends grow at approximately​ 12% for the first four years and 11% from year five to the foreseeable future. The higher growth in dividends in the earlier years causes the stock of Gang Busters Group to be worth more than the Steady​ Freddie, Inc., stock.

Answer 1

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| 0 = = = = = 3 g v 1* 01:00 ENG 09-02-2070 33 fix BF577 - AY X AZ BA BB BC BD BE BE BG BH 555 1 BUGGIES ARE US g=0%, ke -11%, D1 = 2.14 PO = D1/(ke-g) = 2.14/(0.11-0) = 19.45 2 STEADY FREDDIE INC g=7%, ke -11%, D1 = DO*(1+g) = 2.14*(1+0.07) = 2.2898 PO = D1/(ke-g) = 2.2898/(0.11-0.07) = 57.25 567 568 569 570 571 3 GANG BUSTER GROUP DO D1 D2 2.14 2.41 2.71 3.05 3.43 3.67 (3.43*(1+0.07)) D5 GROWTH RATE OF 4 YEARS = 576 577 FV 2.14 3.43 12.52% (=RATE(4,,-BB576,BB577)] 578 579 KE CAPM UTILITY, SHARPE, beta coNvexity DGM beta port future INDEX INTL CAP BUD SANDRINE LEASING PV, FV, ANNUITY DIR right clean YIEL ... ►

| 0 = = = = = 3 g ? v . ** 01:01 ENG 09-02-2020 " 33 X AY603 fix AY X AZ BA BB BC BD BE BE BG BH 579 g= 7%, D5 = 3.67, P4 = D5/(ke-g) = 3.67/(0.11-0.07) = 91.75 DIV +P4 585 D1 D2 PV FACTOR AT 11% PV OF DIV + P4 2.41 0.90090 2.17 2.71 0.81162 2.20 3.05 0.73119 2.23 95.18 0.65873 62.70 PO = 69.30 D4+P4 586 587 588 589 590 ANSWER:A: NO GROWTH RATE FOR BUGGIES ARE US, CONSTANT 7% GROWTH RATE FOR STEADY FREDDIE INC APPROX 12% GROWTH FOR 4 YEARS AND THEN 7% FOR GANG BUSTER GROUP HIGHER GROWTH RATE IN EARLIER YEARS LEAD TO HIGHER PRICE OF STOCK 593 594 598 599 600 601 602 603 KE CAPM UTILITY, SHARPE, beta convexity DGM beta port future INDEX INTL CAP BUD SANDRINE LEASING PV, FV. ANNUITY DIR right clean YIEL ... ►